Cain & Cain, Estate Planners for Life™ believes in creating estate plans that really work and feels strongly that estate planning is a process and not an event. Estate plans must be maintained and updated because of changes in the law, the tax system, the family, mobility of family helpers, and Cain & Cain’s own constantly evolving methods for addressing client’s issues.

A recent U.S. Supreme Court case, Clark v. Rameker, presents a classic example of one of the primary fears a parent has when leaving assets to his or her children. Ruth Heffron (Mom) died in 2001 and left her $450,000 IRA to her daughter Heidi Heffron-Clark (Daughter) individually as beneficiary. In 2010 the IRA was worth approximately $300,000 when Daughter and her husband filed bankruptcy.

Prior to Clark there was a split of opinion in the Circuit Courts on whether an inherited IRA was afforded creditor protection. The Clark case found its way to the U.S, Supreme Court to decide the issue whether inherited IRAs (traditional or Roth) were exempt assets under the bankruptcy code. The Daughter’s attorney argued that the bankruptcy statute, 11 U. S. C. Section 522 (b) (3) (C), should exempt Daughter’s inherited IRA assets from creditor claims against her bankruptcy estate. The Court stated that the bankruptcy statute protects “retirement funds” to the extent that those funds are in a fund or account that is exempt from taxation under sections 401, 403, 408, 408A, 414, 457 or 501 (a) of the Internal Revenue Code.

Although Mom’s funds were in an account exempt from taxation under IRC §408 (an IRA), the Court held that once Daughter inherited the IRA, it was not considered “retirement funds” anymore. The Court supported its conclusion by citing three legal characteristics of inherited IRAs that differentiate it from an IRA owned by the original participant:

1) The holder of an inherited IRA may never invest additional money in the account.

2) The holder of an inherited IRA is required to withdraw money from such account, no matter how many years they may be from retirement.

3) The holder of an inherited IRA may withdraw the entire balance of the account at any time-and for any purpose-without penalty.

Since the Court reasoned that inherited IRA assets are no longer considered “retirement funds”, Daughter’s inherited IRA was now exposed to her creditors. In our experience, clients want to limit this type of creditor exposure for their assets (whether in an IRA or not). Consequently, when counseling clients on their IRA beneficiary designation options we have generally recommended that they name their trust as primary beneficiary, and if married, their spouse as contingent beneficiary. If it is a single client, we have generally recommended their trust or one of the lifetime protective sub trusts created under their trust be named the primary beneficiary.

This case now confirms the wisdom and value of our approach of naming your trust as beneficiary, as opposed to your children or beneficiaries in their individual name. We will be discussing this case in more detail at our upcoming Annual Client Meetings. We look forward to seeing you there!